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Christopher Phelps
Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2710
Experience:  CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
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Buying a house for parents

Customer Question

I am thinking of buying a house for my aging parents so they will be closer to me so I can care for them. It would be a lease property, thus a tax write off for my husband and myself. Plus it would help my parents as they would not have to buy and finance a house. My questions are:

1. When we sell their paid for house, which is in my name (it will probably be worth 50 to 60K, should we put the money all down on the house we want to purchase, which is 128,00 to lower the house payment?

2. Or should be put the money into a savings account of some sort, and just pay the house payment? If we do this do we have to pay capital gains tax on the sale of their house?

3. If we are going to call it a "lease" house, but my husband and I will really be paying the house note, can we do this and still call it a "lease" house and reap the tax benefits that entails? or do we have to charge my parents something? Can it be $1, $10, $100 per month, or does it have to be closer to market value??? How does that impact claiming a loss at the end of the year or reporting the money as income on a lease property?
Submitted: 12 years ago.
Category: Tax
Expert:  Christopher Phelps replied 12 years ago.

With respect to your question about financing, I recommend that you make a downpayment of at least 20% to prevent PMI (private mortgage insurance) from being tacked on as an additional expense. Beyond that how much additional down payment depends on your other investment options as well as well as your available cash flow.

With respect to the "potential" tax deduction associated with rental properties. You will only be able to treat the property as a rental, properly reportable on schedule E on your 1040 return, if you charge your parents a fair market value rent. I would even recommend that you have a standard, written lease commonly used in your area drawn up and adhered to. Further, I would recommend that you establish a separate bank account to receive rental receipts and make payments from for all expenses. Doing so establishes that you are treating the property as an investment rather then as a personal property or second residence.

The issue here is that you are going to have family residing in the property. By having your parents in the property without charging a fair market value rent, the IRS will disallow all deductions associated with the property except for property taxes and mortgage interest. Under Internal Revenue Code Sec. 280A your parents are considered family and their use of the property without paying rent (or paying a below market rent) would be considered "personal use". Their use would be attributable to you, thus, it would be as if you used the home as your second residence.

In order to be able to deduct expenses beyond property taxes and mortgage interest (i.e. H.O.A. fees, insurance, gardening, repairs, depreciation) you need to treat the rental like an investment/business and your parents as if they were not your relatives. Otherwise, you just have a second residence that you treat for tax purposes just like your primary residence.

The only difference between your primary residence and this second residence would be that when you sell it you will not be able to take advantage of the once every two year gain exclusion ($250K if single, $500k if MFJ) available under IRC Sec. 121 for primary residences. Instead any gain would be subject to tax. If you held the property more then one year the maximum tax rate would be 15% capital gains tax (5% to the extent the gain would be subject to the 10% and 15% brackets). If the property is held for one year or less the gain is treated as ordinary income subject to tax at your marginal tax rate (i.e. like wages and interest income).

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Customer: replied 12 years ago.
Reply to Christopher Phelps's Post: Since June 13 and your very thorough answer I have discovered that my parents went to an attorney in 1999 to ask for protection for their home to never be taken from a nursing home and to ensure my inheritance. The attorney set up a life estate. Until about 6 days ago, my parents nor I had any idea about what this meant, the implications, nor that there was such a thing. Since we are trying to sell their house and my husband and I are trying to buy them a house to be closer to us for their care, lots of questions have come up regarding this situation. My questions now are:

1. When their house is sold, will my husband and i have to pay capital gains on the profit? This will be substantial, because they bought their house in 1960.

2. Since there is a warranty deed drawn up, can I deed it back to my father and then he could sell his house and retain the profit and pay no capital gains? Or does he have to meet the 2 year requirement of owning the house. (He definitely meets the "lived there" criteria)

3. If no capital gains are involved, should we simply sell the house, (we are all in agreement) and there is nothing to worry about?

4. If he does have to meet the 2 year requirement of ownership and he was not the owner under the life estate, but rather I was the owner (I'm not even sure if that's how it works), could we possibly get around the 2 year requirement because of the ailing health and the necessity to be near me, their only child, to have care provided to them?

5. If we are totally screwed for the next two years, is there any recourse on an attorney who offered such poor advice to two middle class, trusting elderly people, who thought they were protecting their child. Since this has all come to light, I have discovered that nursing home cannot even take your property. That a home does not count against you. Plus, I have discovered that my father would never qualify for a medicaid facility anyway, because of his pension and social security. Is there any recourse, because the attorney misguided them into something that was not necessary for them and was not their intent?

Thanks, XXXXX XXXXX desperate. We have found a home for them and need to make an offer, but cannot afford to be hit with a capital gains tax.
Expert:  Christopher Phelps replied 12 years ago.

Lets slow down and make sure I understand what happened. If I read you questions correctly, the attorney apparently structured some sort of arrangement whereby you succeeded to ownership of the property but your parents retained a life estate (i.e. the ability to remain in the house until they die).

If you can please give me specifics on how this was accomplished. Was the house deeded outright to you or was it placed in a trust with you as trustee? Was a gift tax return (i.e. Form 709) ever filed by the attorney or someone else? Who was responsible for maintaining the property, paying property taxes, mortgage payments (if any), etc.?

Whatever you can tell me about how the home was titled throughout htis process will help.

Customer: replied 12 years ago.
Reply to Christopher Phelps's Post: Mr. Phelps,

The house was deeded to me through a warranty deed. My father did not file a gift tax form because he did not know he needed to. However, his CPA will be doing that. In the warranty deed the life estate was established. I think I'm understanding that a formula is used to determine which part I own and which part they own. Upon the death of my father the life estate will cease, but, if we have to sell before his death, will my husband and I and my father have to pay capital gains, or just my husband and me?

How can my father protect the money he receives for the sale?

My name is XXXXX XXXXX their acounts, saving, checking etc? Would this be enough to prevent a lein against my father's money?

This whole life estate thing is so confusing, should be just deed the property back to my dad or can we transfer it to some kind of grantor irrevocable trust?

Thanks for all your help and information.
Expert:  Christopher Phelps replied 12 years ago.

I am not sure what a "warranty deed" is or what rights it confers. I would go back to the attorney and have him/her explain the purpose of the structure and what rights it confers on everybody. Because I have not seen the paperwork it is difficult for me to determine who owns the property and who has the right to sell or transfer what (the attorney should be able to clear this up). Whoever has the right to sell/transfer the property (or some portion of it) will bear the associated tax burden.

My take (and its just my opinion from afar) is that you likely have full ownership subject to the life estate. You would likely need your father's permission to sell (i.e. cancel the life estate). Whether this constitues a taxable gift I am not sure since it would be difficult to value. If you convert the property back to your father so he can sell it, you will likely have made a taxable gift back to him.

I suspect the structure of this deal has more to do with medicaid protection (i.e. to prevent the house from being liened to recoup medicaid expenses) then anything else.

First, go to the attorney and get as many facts as you can about the purpose of the original transaction and the rights of all parties under this arrangement. If the reason for structuring the original gift still remains, you will need to explore with the attorney ways you could monetize the equity in the property while still meeting the objective. Next, take all these facts and potential strategies and see a competent CPA who could advise you on all the tax ramifications.

Unfortunately, I think this is the best I can do without seeing all the paperwork and talking with the original parties. You can get it straightened out by following the above steps.